We asked professionals at three big money managers, T. Rowe Price, Franklin Templeton and BlackRock for their thoughts on how the stock market will shape up next year.
On the outlook for stocks
A double-digit gain is not out of the question.
Many of the tail winds for the stock market are still in place, but they may start to weaken next year. Corporate earnings are strong, but profit margins could be peaking. Interest rates are still low compared to historical levels, but will likely rise gradually, particularly if the Fed starts to pull-back on its bond-buying stimulus program.
However, the biggest challenge to the stock market is that valuations have risen so much this year, says Larry Puglia, portfolio manager of T. Rowe Price's Blue Chip Growth fund. That is to say, investors have been willing to pay more for a company's future earnings, pushing up prices. The price-earnings ratio for S&P 500 companies has risen to 15 from 12.5 at the start of this year, according to FactSet.
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"We still find selected stocks attractive and think that the market's OK, but I would be surprised if the market....was able to duplicate the type of gains we've had this year," says Puglia. He still thinks stocks could rise as much as 10 percent.
Conrad Hermann, a portfolio manager at Franklin Templeton says that statistics show that when the market logs an annual gain of 20 percent or more, it has been followed by another year of gains on two out three occasions -- for an average gain of 11.5 percent the next year.
On the best industry to invest in
Technology companies are the big favorite.
The tech industry should benefit from rising spending in an improving global economy, says BlackRock's chief investment strategist Russ Koesterich. He also says that technology stocks are typically less sensitive to rising interest rates than other industry groups are.
Many tech stocks don't pay a dividend, making them less sensitive to higher bond yields, and with strong new products they should grow profits. That suggests if interest rates climb, tech stocks should perform better than the overall market.
Tech companies are also less richly priced than some other parts of the market, while still offering good growth prospects. Those in the S&P 500 are trading at 14.4 times their projected earnings over the next 12 months. That makes them less expensive than health care stocks, which are priced at 16.7 times expected earnings, and industrial companies, which are valued at 16.1 times earnings.
On a reduction of fed stimulus
Investors have been obsessed with the Fed all year and the stock market's biggest setbacks have come when they thought that policymakers were poised to cut back on economic stimulus.
The S&P 500 has dropped in only two months this year, June and August. In both months investors sold stocks on concern that the Fed was about to stop its stimulus.